Cash demand was falling before note ban

Even before demonetisation was announced, demand for cash from the public had been reducing month by month, indicating that people were either battling a slowdown or their preferences were shifting to digital payments, an analysis of the Reserve Bank of India (RBI) data shows.

The ‘currency with the public’ component of the money supply grew at a declining rate during the first six months of 2016, and thereafter grew negative. That is a reflection of demand, rather than RBI’s intention to curb cash payment.

Arun Kumar, former professor of economics at Jawaharlal Nehru University (JNU) in New Delhi, says currency in circulation is basically a question of how much is required, “and if the demand is slowing down or people are buying less, then the RBI wouldn’t need to supply extra cash”.

Given that the unorganised sector is more dependent on cash, the data portends there was a slowdown in the informal economy in 2016 even before demonetisation was announced, say economists.

A drop in demand for cash is a tell-tale sign of a slowdown as the digital mode of payments has only recently started showing some appreciable share in total transactions.

“What has happened in the past 15 to 16 months is that demand for currency has fallen, as in the organised sector there is more digitisation, while in the unorganised sector there is a slump,” says Kumar.

The November 8, 2016 demonetisation culled the currency with the public from ~17,013.8 billion at the start of the month to ~7,809.5 billion by the month-end, while the government, the RBI, and banks started pushing digital payments aggressively.

But, demonetisation did force people to adopt digital means of payments. According to bankers, the move saved banks three years of sustained campaigning for digitisation, but experts have questioned if invalidating 86 per cent of currency in circulation and taking a hit on economy was well worth it.

Currency with the public (CwP) is a component of money supply in which the RBI has no direct control. The apex bank, instead, uses open-market operations or the adjustment of the cash reserve ratio (CRR) and the liquidity reserve ratio, to spur credit growth (or contract credit) by banks or other types of lending.

For example, the RBI can increase the CRR from 4 per cent currently and remove liquidity from the banks, curbing their lending exercise and therefore limiting CwP.

CwP, along with demand and deposits with the banks, as well as ‘other’ deposits with the RBI, makes up the M3 measure of money supply. M3 is the broadest measure of money supply and can include institutional money market funds and other liquid assets.

Looking at the RBI data, the percentage change in CwP fell to (-)54.1 per cent in December 2016 from a month ago, and rose to ~7,829.1 billion, a 0.3 per cent rise, in January. Given this low base, CwP grew to ~8,803 billion, or 25.2 per cent, in February 2017. This means that in December 2016, demand for cash by the public fell to half of what they had demanded in January of the same year.

During 2017, CwP grew positively at an average of 6.4 per cent throughout the year, but at a declining monthly rate. The CwP in December 2017 was 94.6 per cent of the CwP level prior to demonetisation.

However, if we compare CwP to M3, which gives us a better look at cash demand from the public in the context of how much deposits the public had with the banks, the CwP/M3 ratio remains broadly the same throughout the two years.

CwP/M3 rose from 7.2 per cent in July 2016 to 15.4 in January 2017, and then declined again to 8 per cent in July last year, once remonetisation had replenished the economy with the requisite cash.

Interestingly, it seems that without demonetisation, people’s demand for cash would have kept reducing due to an economic slowdown. And despite demonetisation being a boost for encouraging digital forms of payment, according to the RBI data, it seems demand for cash throughout 2017 was higher than in 2016 (CwP/M3).